Restoring compliance with the new SEC Act

The SEC believes that compliance with fit and proper standards is essential to ensure that its business activities in the securities market are conducted with a high standard of market practices and integrity. This system of suitability and accuracy is primarily intended to act as a gatekeeper. This ensures the level of competence and integrity required for the key positions of the regulated entities 

It is essential to comprehend what the newly-institutionalised SEC Act No. 19 of 2021, which replaces No. 36 of 1987, is meant to accomplish. The new SEC Act goes beyond simply creating and maintaining a market in which securities can be issued and traded in an orderly and fair manner to regulate the market in conformity with the provisions of the new Act under the purview of the SEC and instituting a transparent securities market that protects the interests of both domestic and foreign investors while ensuring the highest professional standards and industry best practices

How effective is our regulation for the capital market to prevent ineffective practices? Effective regulation establishes the foundation for investor confidence, promotes the efficient functioning of the capital market, and thus lays the foundation for economic growth. 

It is critical that our regulatory environment is relevant and effective, and that our securities law is tailored to market needs and international best practices. To address the rising concerns the Securities and Exchange Commission (SEC) of Sri Lanka embraced a new SEC Act, No. 19 of 2021, to replace No. 36 of 1987. The new SEC Act represents a new paradigm for regulatory approaches. It is timely and addresses a new disclosure-based regulatory system that stakeholders should be aware of.  

A few months ago, severe concerns about the new SEC Bill were raised, exposing several unpleasant elements. However, now the Bill has become an Act that requires market participants to comply with it. While many continue to debate that the new Act is too stringent, the industry experts shed light on different perspectives and what to look for as market participants in the seminar/webinar hosted by Asian Pathfinder and Corporate Legal Consultants in collaboration with the Daily FT at Shangri-La on 22 October. 

The seminar/webinar featured former DG of SEC Sri Lanka and Chairman Dr. D. C. Jayasuriya, Precedent Partner of Nithya Partners and former DG of SEC Sri Lanka Dr. Arittha Wikramanayake, Chief Executive Officer of PwC Sujeewa Mudalige, Chief Executive Officer of LOLC General Insurance and former Director Legal of SEC Sri Lanka Kithsiri Gunawardena, and former DG of SEC Sri Lanka and Senior Advisor of Ministry of Finance Malik Cader. 

The seminar emphasised the key provisions that market participants such as directors and senior management of listed companies, auditors and accountants, company secretaries, stockbrokers, entities regulated by the SEC, regulators, lawyers and compliance managers, and investors should be aware of.  This article is a collation of thoughts expressed at the forum.

Overview

As a first step, it is essential to comprehend what the newly-institutionalised SEC Act No. 19 of 2021, which replaces No. 36 of 1987, is meant to accomplish. The new SEC Act goes beyond simply creating and maintaining a market in which securities can be issued and traded in an orderly and fair manner to regulate the market in conformity with the provisions of the new Act under the purview of the SEC and instituting a transparent securities market that protects the interests of both domestic and foreign investors while ensuring the highest professional standards and industry best practices.  

Despite the fact that the Act has many positive aspects, the regulator has far too much discretion to ensure that regulatory functions can be carried out in a more meaningful and effective way. Giving such power to this extent to a single entity can be a threat. 

While many may debate on how much power and authority should be vested to the SEC, the Commission is not exempt and, like any other public authority given authority and discretion, must exercise those authorities and discretion in accordance with the law and in all cases obey the rules of natural justice. It is important to note that the authority and discretion of the Commission are limited by a number of checks and balances that are accountable to the Commission and designed not to exceed that authority under any circumstances.

Issue of securities 

Part III deals with the issuance of securities, and the purpose of this part is, among other things, to ensure the timely disclosure of financial information by listed companies and the adherence to best corporate governance practices. To ensure accountability for public offering funds, the Commission may adopt rules that require unlisted companies to seek consent prior to certain types of the public offering, if deemed necessary. 

This requirement can be introduced by considering the quantity of securities, type of securities, number, and type of investors, type of issuer, or type of securities market. This would mean that the SEC is extending its hand to regulate unlisted securities. In the absence of a marketplace for unlisted securities to trade one wonders the applicability and enforceability of offences stated in this act.  

Market intermediaries play a central role in the functioning of the market. Ensuring their credibility is essential because they are at the forefront of the market and therefore in direct contact with investors. To achieve this and perform tasks more efficiently, specific requirements are identified under the heading ‘Protecting Client Assets’. 

It is also important to note that the new Act redefined ‘market intermediaries’ and added several more categories of people. They are corporate finance advisors, market makers, derivative brokers, and derivative traders. The introduction of market makers is important because it guarantees continuous and efficient securities exchanges between buyers and sellers. 

 Market misconduct 

How common have market offences been? Watch out for Section V of the Act on dealing with major market offences which can be seen as a positive initiative towards regulating the country’s securities market. This section addresses two parts: Prohibited Conduct and Insider Trading.

The new act identifies five different violations under Prohibited Conduct. They are: 

I. False trading and market rigging: False trading and market rigging are acts that give a false impression of the volume of transactions on a stock exchange. 

II. Stock market manipulations: Market manipulation is the Act of artificially inflating or deflating the price of a security or the Act of influencing market behaviour for personal gain. 

III. Making false or misleading statements: The law prohibits making false or misleading statements or disseminating information in important details which can raise, lower, maintain, or stabilise the market price or volume of securities traded on an exchange licensed by the Commission or a platform operated by a recognised market operator. 

IV. Fraudulently inducing persons to deal in securities: Inducing or attempting to trade securities with others that are traded on a platform operated by an exchange or market operator authorised by the Commission is not permissible. 

V. Use of manipulative and deceptive devices:  A person shall not directly or indirectly be in connection with the subscription, purchase, or sale of any securities traded on an exchange licensed by the Commission or a platform operated by a recognised market operator.

The newly-instituted market offences under this Act include making or disclosing false or misleading statements that have a material impact on increasing or decreasing market price or volume of securities and inducing or trying to influence another person to trade by making or publishing any misleading, false, or deceptive statement or forecast.   

Albeit the new Act imposes a burden on the market that it is not yet prepared to handle, the market participants cannot turn away from the law. Looking on the bright side, the market participants should learn to harmonise and conform to the new SEC Act for a fair, orderly, efficient, and transparent securities market

Insider trading 

Are you doing insider trading accidentally? Well, it might get you into serious trouble even accidentally, without any intent to violate the law. All facets of insider trading including who is considered an insider, prohibited behaviour of such individuals, what qualifies for information, charges for disseminating such information, and exceptions to disclosures of such information have been discussed thoroughly in the new Act with absolute certainty. The clear delineation on market offences does not only create awareness among market participants on the implications of contravening the Act but also informs and directs regulators to take remedial actions towards uplifting the integrity of our securities market.  

While many wonder “What could be most effective ways to punish market offences?” in contrast to the previous Act, these market offences can now be tried in High Court instead of Magistrate Court and those convicted of such an offense will face a penalty of either a fine of not less than Rs. 10 million or imprisonment for a term not exceeding 10 years or both such fine and imprisonment and these offences under Part V of the act are not compoundable. 

Tips on avoiding insider dealing 

Are you triggering insider trading? Insider tipping is illegal and it triggers insider trading. The seminar highlighted thirteen effective ways to avoid getting caught up in insider trading offences. They are:  

(1) developing awareness of whom you are dealing with and their background,  

(2) taking additional measures or precautions in interactions outside of the office,  

(3) creating awareness on sensitive non-public information among staff, third parties, and regular suppliers with the help of compliance/legal teams,  

(4) establishing a robust whistle-blower scheme, 

(5) setting black-out periods,  

(6) providing mandatory time-off for those who are generally privy to price-sensitive information,  

(7) prompt reporting of any insider trading, unlawful disclosure, or market manipulation concerns to their manager, HR, or the compliance team,  

(8) probing and documenting the work history of job candidates which will provide as evidence if any suspicious activity is discovered, 

(9) watching out for irregular trading patterns, 

(10) paying attention to calls during busy hours and pre-reviewing interviews that are yet to be published,  

(11) refraining from disclosing non-public sensitive information to outsiders including but not limited to takeovers, mergers, earnings, profit, change of CEOs, warnings, litigation or security offerings,  

(12) refraining from recommending or inducing trading based on inside information, and  

(13) refraining from sharing improper information with overlapping work relationships such as socialising with former colleagues.   

Role of auditors 

Another new feature is that the role of auditors is expansive under the new Act. Auditors of listed companies, market institutions, and market intermediaries are obliged to report certain activities they notice while performing their duties. The new Act clearly states what they are and to whom they must be reported. 

In the event of a breach of rules or regulations that could have a material impact on the financial position of a listed company, the auditor will immediately report in writing to the Audit Committee and, if corrective action is not taken within two weeks, then the matter has to be escalated to the board of directors in writing to rectify the breach or to prevent the execution of a breach that has not yet occurred. If no action is taken, the auditor must notify the commission and the stock exchange, and the shareholders accordingly. 

With the new Act, auditors are empowered to intervene and create an environment in which investors can trade more comfortably in securities markets and maintain the transparency of all market functions. 

Fit and proper criteria 

The SEC believes that compliance with fit and proper standards is essential to ensure that its business activities in the securities market are conducted with a high standard of market practices and integrity. This system of suitability and accuracy is primarily intended to act as a gatekeeper. This ensures the level of competence and integrity required for the key positions of the regulated entities. 

The assessment is first made when the application for approval or registration is considered and is ongoing, considering ongoing business operations and previous compliance with all applicable laws and regulations. The fitness and propriety of top management of the supervised company is important for achieving the supervisory objectives. The primary responsibility for ensuring that the monitored company is carefully and soundly managed and controlled lies with the monitored company itself. 

With these criteria, the SEC expects market participants regulated by it to take the necessary steps to ensure that directors and senior managers, who have a significant impact on their business meet the fitness, propriety, or other qualification tests of the regulator. 

The new Act Section 89. (1) The board of directors of every listed public company shall ensure that the company and its directors comply with the rules and requirements of the exchange on which it is listed on a continuous basis as long as the company remains listed on such exchange.

(2) The directors OR chief executive officer of a listed public company shall comply with the fit and proper criteria specified by the Commission by rules or in the rules of an exchange approved by the Commission.

The concept of governance revolves around good and credible people. “No amount of rules and regulations can you make a crooked man straight.” If Section 89(2) was drafted as “The directors AND chief executive officer of a listed public company” a fair attempt can be made, and it is hopeful that the crooked will not find a place in the Sri Lanka corporate. It will also serve in the right direction by weaning off the bad and introducing the good into the boards of companies.  Currently, the board can get away by asking the CEO to comply with the fit and proper criteria.  

Albeit the new Act imposes a burden on the market that it is not yet prepared to handle, the market participants cannot turn away from the law. Looking on the bright side, the market participants should learn to harmonise and conform to the new SEC Act for a fair, orderly, efficient, and transparent securities market.

(The writer is a Lawyer, a former Director General of Securities and Exchange Commission of Sri Lanka and a former Senior Advisor to the Minister of Finance. He can be contacted at [email protected])